As seen in the latest issue of Master Investor Magazine
“In terms of VR, I don’t think it is a niche.”
– Tim Cook, Apple CEO
Dawn of a New Age
Radio, telephone, television, the Internet: our world has been shaped by intermittent waves of game-changing technology. All of the innovations listed above were once unthinkable but are now ubiquitous. Perhaps the best example of how quickly our daily lives can be impacted via technological change is the smartphone: in 2007, when Steve Jobs unveiled the iPhone, global smartphone shipments numbered just 120-125 million units; by 2015, that number had risen to 1.4 billion units. What was only recently thought of as a luxury is now an integral part of everyday life.
Many informed commentators now believe it is the turn of Virtual Reality (VR) to assert itself in the mainstream. VR has the potential to have a fundamental impact on the way we work, play and communicate. The revolutionary nature of this new medium is encapsulated in the notion that it will be the first to truly re-route the human sensory system. While estimates of the potential economic impact of this technology vary quite significantly, what is clear is that some of the world’s largest technology companies are taking VR very seriously indeed. On that note, investors should too!
The Tipping Point
The concept of VR is not new: it can be traced back to the 1960s when Ivan E. Sutherland, the “father of computer graphics” invented the first VR/AR (augmented reality) head-mounted display, to the 1990s when Nintendo launched its “Virtual Boy” gaming headset. However, until now, the technology infrastructure has not been sufficiently advanced in order for VR to gain traction in the mainstream. VR disappeared from the public consciousness in the late 1990s as the technology sector began to concentrate on other verticals such as the internet and mobile telecommunications.
After a long hibernation, it appears that VR could now come of age. In 2012, 18-year-old entrepreneur Palmer Luckey launched a crowdfunding campaign to raise $250,000 to develop a low-cost VR headset that would be linked to a smartphone. The name of the project was Oculus Rift. The initial funding target of $250,000 was hit within 24 hours of the launch, and Oculus eventually raised $2.4 million from 9,500 backers. Incredibly, this money was also raised without any promise of a return on investment: clearly there was an appetite to see this kind of technology become a reality.
The technology used by Oculus – and its competitors – has only been made possible by advances driven by the smartphone revolution, from the miniaturisation of processing technology to the reduction in the size and cost of sensors. The technology’s major endorsement came in 2014 when Oculus was acquired by Facebook (NASDAQ:FB) in a $2 billion deal. Other major tech players have taken note and the race for the VR industry has now well and truly begun.
So where do things stand in terms of the uptake of VR technology? The installed userbase for VR in 2016 is just north of 50 million units, according to HSBC. If we consider how similar game-changing industries compared at equivalent stages in their development, it is clear that we are still in the ‘colonisation’ period for this new technology. For example, there were only 1.11 million PCs sold in the US in 1981 when the first IBM PC was introduced; by 2011, global PC sales reached 363 million units. It’s a similar story for the Internet. Only 4.8% of the US population had internet access in 1995; by 2015 that figure had risen to 87.4%. What begins as a novelty quickly becomes accepted as mainstream once its benefits become apparent and the costs involved are sufficiently low.
Delving a little deeper into the Internet example, the technological capabilities were there for many years before the Internet really took off in a big way. But in 1995 Bill Gates wrote an internal memo entitled “The Internet Tidal Wave” declaring that the Internet was “the most important single development to come along since IBM released their first PC in 1981”. The game-changer was the release of the Netscape web browser, which dramatically improved the user interface when navigating the Internet. The rest is history.
Potential Applications: a New Medium in the Making
Clearly, the low-hanging fruit in terms of VR applications is the video games industry. However, VR’s impact is potentially much more pervasive. In a world where the VR experience is totally immersive, the need to travel, either for work or play, will be progressively eroded. Although real physical interaction will never be completely displaced and will always come at a premium, it is not difficult to imagine a world where a large portion of the public would prefer to participate in various activities from the comfort of their own home, for reasons of both cost and convenience.
So although it is reasonable to expect the entertainment industry – video games, cinema, theme parks etc. – to bear the brunt of the disruptive impact of VR technology, some of the most exciting (in terms of human development) applications come from less obvious corners. The education sector is a good example of an industry that could be completely transformed by VR technology. ‘Virtual’ classrooms could radically reduce the cost of a good education whilst enhancing the quality and the appeal of the educational experience. Field trips could be conducted from the safety of the classroom, as could other interactive experiences that enhance student engagement.
In the healthcare sector, VR has the potential to drastically enhance the quality of life for the disabled and for many elderly people who feel isolated. The ability to visit places without actually being there in person also raises questions for the travel and tourism industry. This could yield benefits in terms of the impact of travel on the environment – indeed, according to Palmer Luckey, “VR is potentially our best shot at real post-scarcity economy.” In a virtual world, the marginal cost of production for the vast majority of products is effectively zero. This of course raises some serious questions in terms of the future composition of the economy.
What Could VR Be Worth?
Given that we have established that the impact of VR technology could be very far-reaching indeed, it is hard to estimate the potential value of this nascent market. According to number crunchers at Goldman Sachs, the VR market could be worth $110 billion annually by 2025, making it larger than the TV market. This is based on Goldman’s “Accelerated Uptake” projection, in which VR becomes more commonplace through advances in battery and cellular technologies. However, it is worth noting that this estimate is based solely on hardware sales. Factor in Goldman’s estimate for VR software sales ($72 billion), and VR would generate $182 billion by 2025, making it worth almost twice as much as the TV market.
Others go further still. HSBC believes that VR will have the most direct impact on the Arts & Entertainment industry, which is currently worth around 4% of US GDP. Assuming VR captures three quarters of that value, they see VR becoming “at minimum” a $500 billion industry “just in the US”. What’s more, taking a holistic approach to analysing the impact of VR on the economy – i.e. through looking at the potential impact on each sector in turn – HSBC suggests that VR could potentially capture as much as 30% of US GDP, or about $5 trillion. Clearly, globally that figure has the potential to be larger still.
Who Will Be the Winners?
There are currently no pure-play VR investments: the key players are the major technology and media companies with investments in VR technology. A key factor in the success of companies’ VR strategies will be their ability to bring developers onboard. In this sense, Sony (TYO:6758) possesses an advantage over competitors in that it has a product – Playstation VR – at an advanced stage of development, in addition to a critical mass of developers already familiar with its Playstation platform. With these considerations in mind, Sony appears well placed to steal a march on rivals, at least in the video games arena. Sony will be up against competition from Facebook’s Oculus Rift as well as HTC Corporation’s (TPE:2498) Vive, a VR headset co-developed with PC gaming company Valve. Vive is said to be a serious contender to Oculus, given its better displays and lower input costs – not to mention Valve’s existing 100 million users.
The other major tech firms have chosen to take a less video game-centric approach to their VR strategies. Microsoft (NASDAQ:MSFT) has focused on developing AR enhancements for engineering and healthcare firms via its partnership with Autodesk. Microsoft HoloLens is its wireless holographic computer, which is now available to developers in the US and Canada. However, at a retail price of $3,000, it is far from being a mainstream offering. At the other end of the spectrum, Alphabet Inc’s (NASDAQ:GOOG) Google Cardboard is an open-source virtual reality platform that uses a simple and inexpensive cardboard viewer that wraps around a smartphone. This low-cost solution establishes Google as a key player in VR and seems to be a clear attempt at a ‘land grab’ that will help spur mass uptake. Samsung (LON:BC94) is also going down the smartphone route with its Gear VR, a virtual reality headset compatible with Samsung Galaxy smart phones and set to retail at $100-$200.
The other major tech giant, Apple (NASDAQ:AAPL), is uncharacteristically quiet on the subject of VR/AR. However, analysts point to two acquisitions as evidence of the firm’s commitment: PrimeSense, a leader in 3D-sensor technology, which was bought for $345 million in 2013; and augmented reality startup Metaio, which was snapped up in 2015. We also know that Apple has filed a patent for a VR headset that works with an iPhone, so it appears that significant progress could be being made behind the scenes.
All this will entail significant demand for a new generation of graphics processing units (GPUs) and specialist sensor technology. All the main chip developers – Intel Corp (NASDAQ:INTC), AMD (NASDAQ:AMD) and Qualcomm (NASDAQ:QCOM) – have exposure in some form or other, but they each have different approaches. AMD are targeting the higher end of the market with their dedicated computer graphics cards, while both Oculus Rift and HTC Vive need at least Intel’s Core i5-4590 or equivalent CPUs for PCs to which they will be tethered. Meanwhile, Qualcomm is gunning for the lower end of the VR market, such as the smartphone-based headset market.
Less obvious plays on the VR revolution include Disney (NYSE:DIS), whose unrivalled content stable place it at the forefront of those content owners who stand to benefit from licensing their IP to VR developers. Elsewhere, market-leading camera lens manufacturer Largan Precision (TPE:3008) stands to gain a significant share of the future shipments of magnifying lenses for VR headsets. According to analysts, the company is well placed to meet demand from a plethora of virtual reality head-mounted-device producers since it is already capable of producing a wide variety of lenses. Finally, Himax Technologies (NASDAQ:HIMX) has its products in three leading AR/VR prototypes currently under development by Facebook, Google, and Microsoft. It manufacturers Liquid Crystal on Silicon (LCOS) chips, or near-eye/projective micro-displays, as well as a detector camera for eye-tracking, an array camera for depth and 3D information, and LCD timing controllers. In other words, this company is involved in much of the ‘nuts and bolts’ of AR/VR hardware.
Putting Together a VR Portfolio
It’s still too early to discern who the major winners will be in the VR revolution, so a more conservative approach for investors looking to gain exposure would be to focus primarily on those firms whose VR strategies are the most advanced – Facebook, Sony and Google – whilst also tucking away some of the more peripheral plays that might surprise on the upside. In addition to their market leadership positions, the former also have solid pre-existing businesses and make worthy portfolio holdings notwithstanding their VR exposure. Meanwhile, companies like Largan and Himax have the potential for significant share price appreciation should VR take off in a major way.
Walt Disney Co. (NYSE:DIS) – Bringing Content to Life
While Disney may not seem like an obvious VR play, its unrivalled stable of entertainment content puts it in an enviable position when it comes to capitalising on the proliferation of VR technology. Just imagine the myriad worlds featured in Star Wars – now owned by Disney via its acquisition of Lucasfilm – brought to life. But not content to wait for VR technology to come knocking on its door, Disney recently led a $65 million round of funding for Jaunt, a cinematic VR startup which specialises in enabling the creation and distribution of premium live-action VR. Clearly this is an early-stage investment and is relatively insignificant in terms of Disney’s current market capitalisation of c. $160 billion. However, given the scope for applying VR technology to Disney’s vast stable of IP, Disney has its place in any VR focused portfolio.
Facebook Inc (NASDAQ:FB) – Turning a New Page in Social Media
Facebook is probably the name that most people currently associate with VR technology, courtesy of its $2 billion acquisition of Oculus Rift back in March 2014. While the most obvious immediate application of Oculus Rift is video games, Facebook CEO Mark Zuckerberg has already made it clear that he intends for the technology to have a much more wide-ranging impact: “Imagine enjoying a courtside seat at a game, studying in a classroom of students and teachers all over the world or consulting with a doctor face-to-face—just by putting on goggles in your home.” Oculus recently launched pre-orders for its Oculus Rift head-mounted-display device, which it will sell at cost for $599. While this may hurt Facebook’s profit margins in the short run, the firm is obviously hoping to steal a march on competitors by getting Rift into as many households as possible. That said, the key to Rift’s success will be Facebook’s ability to bring developers onboard, and eventually produce a franchise along the lines of a Mario (Nintendo), Halo (Xbox) or Uncharted (PS4). Thus far, Rift has failed to achieve this, although admittedly it is still early days.
Sony Corporation (TYO:6758) – Sleeping Giant
Our very own Jim Mellon believes Sony could be the ‘surprise winner’ in the VR race, and if the firm’s past video-game success is anything to go by, he could very well be right. Sony ousted Sega and Nintendo as the dominant force in the video games console industry back in the mid to late ‘90s, and since then has held its own against fierce competition from Microsoft’s Xbox. What’s more, Sony has pedigree in the VR industry, having first researched and developed VR products back in the ‘90s. It is now poised to launch Playstation VR, which creates a 3D experience using a full-HD LCD display and an optical unit with an approximately 100-degree field of view. The product also offers multi-directional sound, while a high-sensitivity accelerometer and gyroscope allows PlayStation VR to detect head movement with almost no latency (fewer than 18 milliseconds). Interestingly, Sony is also said to be the no.1 patent filer in the field of VR, with 366 VR patents or patents pending.
Alphabet Inc (NASDAQ:GOOG) – Taking a Magic Leap
With fingers in many pies, it is unsurprising that Alphabet (formerly known as Google) has established itself as a key player in VR. Google Cardboard is an open-source virtual reality platform that uses a simple inexpensive cardboard viewer that wraps around a smartphone, enabling the usage of a range of virtual reality apps, covering areas such as gaming and entertainment. However, the big move came in October 2014, when Google led a $542 million investment in augmented reality (AR) startup Magic Leap, which places realistic holograms in the user’s field of vision using AR glasses. The conglomerate’s commitment to VR was cemented early this year when it established a virtual reality computing division and appointed Clay Bavor, the executive running its product management team, to run the new arm.